The Treynor Ratio, also known as the reward-to-volatility ratio, is a performance indicator that shows how much excess return a portfolio created for each unit of risk it took on.
The Treynor ratio refers to systematic risk as assessed by the beta of a portfolio. The tendency of a portfolio’s return to alter in reaction to changes in the general market’s return is measured by beta.
Example of Treynor Ratio:
βp=Beta of the portfolio
Suppose the average return generated by your fund is 10%, and the risk-free rate is 6%. The difference between the fund returns and the risk-free rate becomes 4%. If the fund’s historical beta is 2, the Treynor Ratio will be 2 (i.e., 4 divided by 2). It implies that the fund gave two units of return for every additional unit of market risk assumed.
For example, our desired investment is the stock of ABC Corp Plc. The stock has returned an average of 10% annually over the past five years.
The risk-free investment is the UK Treasury Bill which has an interest rate of 1%.
The marker beta is at 1.2.
The Sharpe Ratio calculation = (10% – 1%) / 1.2= 7.5%
Why is it important to know Treynor Ratio?
The Treynor ratio is a risk-adjusted return calculation based on systematic risk. It shows how much money an investment, such as a stock portfolio, a mutual fund, or an exchange-traded fund, made for the level of risk it took on.